Eyes on the prize

First we argued that the cure of the global imbalances by the G7-IMF’s dollar depreciation was more disruptive to the capital markets than the anticipated disease of imbalances themselves.

Second we argued the dollar-depreciation has a poor track record of reducing the U.S. trade deficit. Third, we would also argue that not only is the dollar-depreciation strategy unlikely to significantly reduce the global imbalances, it inflicts actual harm.

Given that policy makers cannot be sure the U.S.-China imbalance will improve even if the Chinese yuan appreciates against the U.S. dollar, the risks of the current strategy seem greater than likely rewards.

Nearly every one agrees the U.S. external imbalance is not sustainable, but the sense of urgency articulated by some U.S. officials does not seem justified. There are more pressing issues — including Iran, North Korea, Taiwan, the regional arms race, and environmental issues — for which Chinese cooperation is critical, and which appear to have a higher probability of success.

Emphasizing foreign exchange may misunderstand how nations compete in the modern global economy. U.S.-headquartered companies in a number of industries have organized their activity in terms of the North American continent. Although outsourcing tends to grab headlines, multinational companies have in-sourced trade — that is, the movement of goods and services within the same company counts for more than a third of global trade and half of the U.S. trade deficit. For example, a component that is made in the U.S. is exported to Canada, where it gets incorporated into a larger product that gets sent back to the parent company, which then distributes the final product. This typifies the economy ushered in by NAFTA.

Our 19th-century way of accounting tells us this is a trade deficit, but it is not. It is moving a good from one side of the factory floor to the other, and the 49th parallel just happens to weave in and out of the factory.

In addition, many policy makers and economists seem to have an outmoded understanding of how U.S. companies service foreign markets. It is not simply by exporting, even though the U.S. is the world’s biggest exporter. Rather America’s contribution to commercial empire is “build locally, sell locally,” so the sales of affiliates of U.S. multinational companies outstrips exports by a ratio of three to one.

There are many ways China competes in the world economy. The relatively cheap currency may help, but policy makers are mistaken if they think it is the only way, or even a critical competitive element. China competes in the world economy through its cheap and docile work force. The Asian Development Bank estimates that Chinese manufacturing wages are 1/33 of U.S. levels. Workers in this “workers paradise” are not allowed to unionize and do not have social security or unemployment insurance. Universal health care has been scrapped.

The Chinese government has also purposely engaged multinational companies to assist in its development. Special economic zones have been established and the Chinese government provides various financial incentives to foreign investors. Indeed, such incentives are so lucrative that some mainland Chinese entrepreneurs reportedly set-up offshore companies to qualify. Companies with foreign links account for around half of China’s manufacturing exports.

To the extent China is told a strong currency is in its interest, there seems to be some tacit recognition an appreciation in the yuan would be beneficial to China — unless we are to believe the officials are cynical and engaged in deception. If history and experience are our guides, rather than economic conjecture, an appreciation of the Chinese yuan would see exporters move up the value-added chain. Low-cost producers who use China as an export platform may migrate elsewhere in the region, leaving the U.S. trade deficit largely unaffected, even if the geographic origin shifts.